Melissa, there is really a fourth group -- comprised of people like me who use MPT. The crux of this approach is to manage risk in the portfolio. Any number of Nobel prizes in economics have been awarded to people who have developed MPT. No major prize in economics has ever been awarded to technical theorists. The reason is simple: there is not one shred of objective evidence to support TA. Show me a single statistically verifiable study which indicates any merit to TA and I will publicly recant and perform all manner of humiliating acts of contrition!
It's like when you were a kid and you could see shapes in the clouds, or when you were in a car and you could hear the windshield wipers beating out a familiar rhythm. TA is like faith-healing because it requires one to be a true believer before it works!
Fundamental analysis suffers from some basic problems as well (although not nearly as great as TA). First, it has no predictive power. Second, it attempts to arrive at valuations by implicitly assuming an inefficient marketplace (which flies in the face of a great deal of empirical evidence). It is, however, quite useful in understanding the dynamics of a company, and it allows the investor to weed out companies which don't meet her investment criteria (i.e. liquidity, ROA, etc.).
If you are interested in this I highly recommend that you read Burton Malkiel's "A Random Walk Down Wall Street". He was President of the American Stock Exchange, and teaches finance at Princeton. This book is virtually required reading in every MBA program in the country.
Here is a final point worth considering. A successful trading strategy inevitably triggers short-term capital gains taxes (unless you are trrading in a tax-deferred vehicle like an IRA). Since estimated taxes are due quarterly, a trading strategy is disadvantaged on two bases: first, the trader must pay a greater per cent of her gain than a buy and hold investor. Second, the tax liability of the buy and hold investor is deferred indefinitely (and capital gains taxes are forgiven for assets that are held at death!). As the Red Queen said, you must run faster just to stay in place!
Let me give you a very simple illustration. Suppose you have an investor who puts up $10,000, and earns 25% per annum for 20 years. At the end of 20 years he cashes out with $867,400 less taxes of 18% of $857,400 for a total of $713,037. This is an after-tax annual return of 23.78%. Now, let's take a trader with a short-term capital gains rate of 28%. In order to net 23.78% after-tax, the trader would need to gross 33%! Actually, the gross would have to be somewhat higher because I've assumed only annual tax payments (when in fact they are required quarterly), and I've ignored transaction costs. (including the services of a CPA to prepare those horrendous tax schedules)
I hope this clarifies some of the ramifications of being a trader vs. being an investor.
Regards,
Paul |
